Mortgage Lenders qualify you using your gross income. Gross income equals your pay before taxes and other deductions come out. Why do lenders using gross income instead of net income?
Gross Income Levels the Playing Field
We all have varying income tax scenarios. In addition, not everyone deducts the same amounts and items from their income. Furthermore, deductions (tax or other) vary over time. Lastly, the amount of taxes deducted are not always equal to taxes owed. In other words some get tax refunds while others owe taxes at years end.
Imagine lenders trying to understand all of these variables related to all borrower’s net income. The margin for error would be huge. Instead, using your gross income is more level and measurable for mortgage lenders.
Non-Taxable Income & Grossing Up
With Gross Income as the common standard, what figure do those with non-taxable income use? For example, oftentimes Social Security Income is non-taxable. For borrowers receiving non-taxable income their income is both their net and gross.
Many loan programs allow lenders to “gross up” non taxable income. Commonly, lenders gross non taxable income up by the the borrowers income tax rate. Doing so results in a borrower receiving non taxable income qualifying using an effective income figure that exceeds their actual income. Grossing up non-taxable income puts borrowers on the same standard relative to what income lenders use (gross or net).
Gross Income & Debt to Income Ratios
A main staple in home loan underwriting is debt to income ratio. This magic number reveals a borrowers debts as a percentage of their income. Lenders calculate this on a monthly basis. In other words, lenders look at monthly debts compared to monthly income.
The income used to determine your debt to income ratio is, yes you guessed it – Gross Income!
By Jeremy House